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The shortfall in the £178 billion Local Government Pension Scheme in England and Wales, which covers council staff such as cleaners, care workers, clerical staff and librarians, has increased in cash terms to £50 billion, according to the most comprehensive recent analysis of its finances.

A Mercer analysis of 80 of the 89 funds in England and Wales estimates an average funding level of around 78%. If applied to all funds, that would mean a liability of £228 billion backed by assets of £178 billion. The figure is dated March 2013, the last valuation date for the component funds. At the previous three-yearly valuation, in 2010, the deficit was put at £38 billion.

However, the report makes clear the scheme’s sensitivity to interest rates, which are being held at rock bottom levels by the Bank of England.

A rise of only half a per cent in the market’s current expectations of future bond yields – which are driven by rates – could improve town halls’ pension finances by about £18 billion.

The deficit increase also masks the fact that the solvency level has remained almost the same during the three years, at 78%. Both assets and liabilities increased exactly in line with each other in percentage terms.

Jo Holden, a partner and head of the local authority investment business at Mercer, said: “We have continued to rely on growth assets and active management and this has done relatively well."

A spokesman for the Department for Communities and Local Government said: “Early indications from the 2013 valuation are that the total scheme deficit is in the order suggested by Mercer, and at a similar level to the 2010 valuation results. That is why the Department has taken steps to reduce costs.”

The government has embarked upon several recent cost-cutting initiatives at the LGPS, with the aim of tackling the shortfall. Most significantly, it introduced new rules earlier this year that will shift the pensions it pays out in future from ones based on members' final salaries, to ones based on members' average salaries throughout their careers.

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And earlier this month, it proposed new measures to cut the scheme's investment costs, including shifting more money to index-tracking funds, which could save up to £790 million a year.

But Holden pointed out that interest rates, and their effect on bond markets, are one of the most significant factors affecting the deficit. Speaking to council pensions officials at the NAPF Local Authority conference last week, she said: “The key point is that we are expecting rises in interest rates, and we may have already taken credit for these happening when calculating funding levels.

“So if yields rise more slowly than we expect in the next few years, we might not get the improvements in funding levels that we expect."

Pension schemes can protect themselves against rates and inflation, to a certain extent, by buying index-linked gilts. Holden said: "So: should we all just buy index-linked gilts? Well, I would say that you need to make an informed decision, and not just assume that gilts are simply too expensive right now.

"If your growth strategy makes excess returns for a sustained period, think about 'banking that' [by moving money into inflation-protected assets like linkers]. And you can get inflation-protection without sacrificing returns. Should you look at infrastructure, and other real assets? Totally – although you should be aware that real assets will not give you any explicit protection against real yields falling, particularly in the shorter term.”

Mercer’s analysis refers to the 89 funds in England and Wales only. There are another 11 in Scotland and one covering Northern Ireland, whose finances are handled separately by devolved administrations in those regions.